The movement to break away from Wall Street and form publicly-owned banks continues to gain momentum. But enthusiasts are deterred by claims that a state-owned bank would violate constitutional prohibitions against “lending the credit of the state.”

California’s constitution is typical. It states in Section 17: “The State shall not in any manner loan its credit, nor shall it subscribe to, or be interested in the stock of any company, association, or corporation . . . .”

The language sounds prohibitive, but what does it mean? Hundreds of state and local government entities extend the credit of the state. State agencies make student loans, small business loans, and farm loans. State infrastructure banks explicitly leverage the credit of the state. Legally, state and local governments are extending their credit to private banks every time they deposit their revenues in those banks. When money is deposited, it becomes the property of the bank by law. The depositor becomes a creditor with an IOU or promise to be repaid. The state or local government has thus lent its money to the bank.

How can these blatant extensions of the state’s credit be reconciled with the constitutional prohibitions against the practice?

The state, any county or city may make internal improvements and may engage in any industry, enterprise or business, not prohibited by article XX of the constitution, but neither the state nor any political subdivision thereof shall otherwise loan or give its credit or make donations to or in aid of any individual, association or corporation except for reasonable support of the poor, nor subscribe to or become the owner of capital stock in any association or corporation.

Yet this prohibition has not prevented the state from establishing its own bank. Currently the nation’s only state-owned depository bank, the Bank of North Dakota has been a stellar success and has been going strong ever since 1919. In Green vs. Frazier, 253 U.S. 233 (1920), the US Supreme Court upheld the bank’s constitutionality against a Fourteenth Amendment challenge and deferred to the state court on the state constitutional issues, which had been decided in the state’s favor.

In the nineteenth century, Mississippi, Arkansas, Florida, Kentucky, and Indiana all had their own state-owned banks. Some were extremely successful (Indiana had a monopoly state-owned bank). These banks, too, withstood constitutional challenge at the US Supreme Court level.

Were the prohibitions against “lending the credit of the state” simply ignored in these cases? Or might that language have meant something else?

The Constitutional Ban on “Bills of Credit”: Colonial Paper Money

Constitutional provisions against lending the state’s credit go back to the mid-nineteenth century. California’s is in its original constitution, dated 1849. There was then no national currency, and the National Bank Act had not yet been passed.

Several decades earlier, the states had been colonies that issued their own currencies in the form of paper scrip. Typically called “bills of credit”, these paper bills literally involved the extension of the colony’s credit. They were credit vouchers used by the colony to pay for goods and services, which were good in trade for an equivalent sum in goods or services in the marketplace.

Prior to the constitutional convention in the summer of 1787, the colonies exercised their own sovereign power over monetary matters, including issuing their own paper money. After the collapse of the Continental currency during the Revolutionary War, largely due to counterfeiting by the British, the framers were so afraid of paper money that they expressly took that power away from the colonies-turned-states, and they failed to expressly give it even to the federal government. Article I, Section 10, of the U.S. Constitution provides:

No State shall . . . coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts; . . . .

Congress was given the power “To coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures.” But language authorizing Congress to “emit Bills of Credit” was struck out after much debate.

The Supreme Court ruled in the Legal Tender Cases after the Civil War that the power to coin money implied the power to print money under the Necessary and Proper Clause, legitimizing the Greenbacks issued by President Lincoln. But in 1850, no state government had the power to extend its own credit in the form of bills of credit or paper money, and whether the federal government had that power was a subject of debate.

However, the expanding economy needed a source of freely-expandable currency and credit, and when local governments could not provide it, private banks filled the void. They issued their own “bank notes” equal to many times their gold holdings, effectively running their own private printing presses.

Was that constitutional? No. The Constitution nowhere gives private banks the power to create the national money supply – and today, private banks are where virtually all of our circulating money supply comes from. Congress ostensibly delegated its authority to issue money to the Federal Reserve in 1913; but it did not delegate that authority to private banks, which have only recently admitted that they do not lend their depositors’ money but actually create new money on their books when they make loans. In the Bank of England’s latest Quarterly Bulletin, it states:

Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money.

This broad exercise of the money power by private banks is nowhere to be found in our federal or state constitutions, but courts have managed to get around that wrinkle. In Constitutional Law in the United States, Emlin McClain summarizes the case law like this:

A state cannot, even for the purpose of borrowing money, exercise the sovereign power of emitting paper currency (Craig v. Missouri). But this prohibition does not interfere with the power of a state to authorize banks to issue bank notes in the form of due-bills or of similar character, intended to pass as currency on the faith and credit of the bank itself, and not of the state which authorizes their issuance.

The anomalous result is that state-chartered banks are able to issue credit that passes as currency, while state governments are not. But so the cases hold, and they apply to public banks as well as private banks.

Public Banks Held Constitutional

John Thom Holdsworth wrote in Money and Banking (1937) that in the mid-nineteenth century, “several of the states established banks owned entirely or in part by the state. There was some question as to the right of these state institutions to issue circulating notes, but the Supreme Court held that such notes were not ‘bills of credit’ within the meaning of the constitutional prohibition.”

The Court narrowly defined the sort of “bill of credit” prohibited by Article 1, Section 10, as a note issued by the state, on the faith of the state, designed to circulate as money. Since the notes in question were redeemable by the bank and not by the state itself, they were not “bills of credit” for constitutional purposes. The Court found that the notes were backed by the resources of the bank rather than the credit of the state. Moreover, the bank could sue and be sued separate from the state.

These cases are still good law. A state bank – or city bank or county bank – is not in violation of state constitutional prohibitions against lending the credit of the state.

For county-owned banks, the case is not as clear. In California, Government Code 23005 forbids counties from giving their “credit to or in aid of any person or corporation. An indebtedness or liability incurred contrary to this chapter is void.” But the US Supreme Court rulings validating state banks should be equally applicable to county banks; and in any case, enabling legislation can be crafted to allow public banks at any level of government.

There is another way to bypass this whole legal debate: by pursuing the initiative and referendum process pioneered in California. It allows state laws to be proposed directly by the public, and the state’s Constitution to be amended either by public petition (the “initiative”) or by the legislature with a proposed constitutional amendment to the electorate (the “referendum”). In California, the initiative is done by writing a proposed constitutional amendment or statute as a petition, which is submitted to the Attorney General along with a modest submission fee. The petition must be signed by registered voters amounting to 8% (for a constitutional amendment) or 5% (for a statute) of the number of people who voted in the most recent election for governor.

Before sufficient signatures could be collected, a widespread educational campaign would need to be mounted; but just informing the public on this little-understood subject could be worth the effort. Recall the words of Henry Ford:

It is well enough that the people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.

When enough people understand that private banks rather than governments create our money supply, imposing interest and fees that constitute an enormous unnecessary drain on the economy and the people, we might wake up to a new day in banking, finance, and the return of local economic sovereignty.

13 Responses

THE CURE by Justaluckyfool:
“DO FOR OURSELVES WHAT WE HAD ALLOWED THE CENTRAL BANK TO DO FOR THE BANKS (PFPB) !
LOAN OUR MONEY AND CHARGE A TAX (interest)ON IT.”
“Why is it so difficult to understand a simple truth: ‘ We the people’ have legislated the right to ‘print’ our money (via loans) and the right to tax that issuance (via interest) to the Private For Profit Banks (PFPB)?”
How is that working for you?

*WHAT IF THE …The Fed Reserve were to become the CENTRAL BANK WORKING FOR THE PEOPLE (CBWFTP) instead of working for the Private For Profit Banks (PFPB) .
Let’s try this game: Substitute the words “Central Bank Working For The People” (CBWFTP) where ever” Private For Profit Banks” (PFPB) appears.
****PFPB have $100 trillion in assets as mortgages on residential and commercial real property (RE) loans. The average compound interest rate is 4% for a term of 30 years. The PFPB would have created that $100 trillion ‘out of thin air’ which would have an attachment that would require $300 trillion to be paid to the PFPB in order for the loan to be paid in full. YES, take away the smoke and mirrors. Now we must replace (reduce to zero ) the initial loan amount by subtracting $100 trillion; leaving a profit,income,taxation from ‘somewhere else’ of $200 trillion. This amount goes as profits to the PFPB. Revenue they may use for their own selfish purposes.
READ IT AGAIN, BUT THIS TIME REPLACE “PFPB” WITH “CBWFTP”.
Why would you not want prosperity for yourselves and your children?
Why would you not want $200 trillion turned over to Congress, to be used..”to form a more perfect Union, establish Justice, insure domestic Tranquility, provide for the common defense, promote the general Welfare, and secure the Blessings of Liberty to ourselves and our Posterity,…”
“A living standard to each according to their need;self-care and mutual service expected from each according to their ability.”
A way and means “…to form a more perfect Union, establish Justice, insure domestic Tranquility, provide for the common defense, promote the general Welfare, and secure the Blessings of Liberty to ourselves and our Posterity,…”

[…] By Ellen Brown The movement to break away from Wall Street and form publicly-owned banks continues to gain momentum. But enthusiasts are deterred by claims that a state-owned bank would violate constitutional prohibitions against “lending the credit of the state.” California’s constitution is typical. It states in Section 17: “The State shall not in any manner loan its […] …read more […]

I think Nevada’s constitution clearly states that the state can not have a bank. Since the legislature meets only every two years, it could take at least four years to change that section, and that is without bank oppositiom

Stupid question – I’m wondering if it’s constitutional for federal govt to print money for retirement accounts. Folks not up on money history, think printing for regular folks, govt needs is inflationary, but what if it went to retirement counts, only to be spent later when retirement age People could use printed money to put into their own accounts like 401k to buy stock or buy into non-profit or public pension trust fund or better yet, govt could give them a guaranteed rate of return, like inflation plus something(TIPS plus) but unlike 401k, it’s untouchable til retirement. Do it on a matching scheme, on any wages FICA taxable, say if employee to contributes 2.5 percent wages,then employer contributes 2.5 percent from employer and govt matches x 2, with 10 percent, yielding 15 percent of salary in retirement savings. This plus Soc Sec should give people decent retirement with small savings. For little cost employer can leverage a “12.5 percent raise “. Wall Street would be bought off a bit, some money could be managed by them. Cost taxpayers nothing. Not available on non-FICA taxable dividends, carried interest or capital gains, they already get tax break. Put the cap at same income FICA is capped at.